Economics

Let's ditch financial bubbles for a second golden age

March 04, 2010
Bubbles: not a good foundation for economies
Bubbles: not a good foundation for economies

Here in the depths of the bust, it is tempting to feel nostalgia for the boom. Let’s not. The bust has been brutal but the boom wasn’t so great either. The British economy actually grew more in 1979, the year of the “winter of discontent,” than it did in 2006 at the height of the bubble. Most of the western economies did better in the late, unlamented 1970s than they ever have since.

For the past 30 years, the world’s engine of growth has been debt-fuelled consumption financed by asset price bubbles. Growth has been sketchy, financial crises common, inequality rampant. Last week I wrote about the fragility of borrowing and spending as an economic strategy and suggested it might be time for our policymakers to find a better one, by taking a look at what worked during the golden age, 1950-1973, the greatest period of growth the world has ever seen.



Back then, our grandparent’s generation managed to double their income in less than twenty years. Their governments shrunk the massive deficits that won second world war without even breaking a sweat. The financial sector was much smaller and much less well paid, taxes were higher, unions stronger. According to the Reagan/Thatcher orthodoxy that mutated into the Clinton/Blair orthodoxy, these policies were a prescription for stagnation. But the golden age created a far richer economy than the neoliberal era that replaced it.

Globalisation, deindustrialisation, deunionisation and the liberation of capital from national boundaries have changed our world irrevocably, but we could still take some lessons from the past. The first and most obvious piece of advice would be to shrink the financial sector. During the last years of the bubble, 40 per cent of US corporate profits were made in banking and finance. That is an unnaturally large share of national wealth going to a handful of people who produce nothing, and whose function is merely to allocate scarce societal savings towards productive investments. Unfortunately, much financial activity doesn’t even do that. Instead of serving the real economy of goods and services, finance has become a parasite on it.

The cure? Unproductive, self-referential transactions should be discouraged. A Tobin tax, the Volker rule, the prohibition of naked credit default swaps would all be a good beginning. Our regulators should demand how society can benefit from financial innovations instead of waiting to watch them blow up in its face. Banking was boring back in the golden age, and we had fewer crises and greater growth. Let’s make it boring again.

Secondly, demand grew during the golden age because of a hugely expanding middle class. Society became much more equal. Productivity increases translated quickly into wage increases, and rapidly rising wages allowed most families to improve their living standards dramatically. Our era is very different. It is not just that the top 10% of society is taking a larger share of the economic pie, it is the top 1%, actually the top .01%. That means everyone else has had to go into debt in order to increase consumption. Our higher debt levels today are the direct consequence of stagnating wages. To return to the golden age, our governments should support a more equitable distribution of income. Perhaps labour should be favoured over capital. In the United States, unionization should be encouraged. For the past 30 years, the economic benefits of massive productivity gains have gone overwhelmingly to the very richest among us. This has to change.

But the biggest difference between the productive golden age and the stagnant current era is their focus on investment and our focus on consumption. Barry Eichengreen, the foremost economic historian of the golden age in Europe, tells us its fundamental secret was a social pact between labour and capital. Labour promised to forgo wage increases greater than productivity gains while capital promised to reinvest profits in the business rather than siphoning them off as dividends. Today, firms will scrimp on investment, maintenance, research and development in order to boost quarterly profit numbers, and so impress Wall Street and goose share prices. This is remarkably short-sighted. Real investment works: giving workers capital goods makes them more productive and it is increased worker productivity that makes societies richer. For the past generation, even as the financial sector expanded, real investment as a share of GDP declined. Productivity gains today come not by providing workers with more capital goods, better machines with which to do their jobs, but rather by firing some workers and making the rest work harder.

Finally, probably because government officials back then had lived through the great depression, their main concern was full employment. Today central banks look first to safeguard the financial system and then to keep inflation down. The real economy is an afterthought to their continued tranquillity. Imagine how many jobs could have been created with the billions spent to bail them out? And yet, despite unemployment rates unseen in decades, a job programme remains unlikely.

Our policymakers want us to return to 2006. They hope that miniscule interest rates and massive government deficits will restart the borrowing and spending cycle that fuelled the boom. Maybe we should be more ambitious. Maybe we should strive to return to the policies of the Golden Age, which focused on real investment and job creation, rather than hoping that if we bail out the bankers once again, they will find it somewhere in their hearts to let some of their wealth trickle down to the rest of us. The biggest lesson of the golden age is that wealth trickles up.